Question

Joe Smith has owned and operated Smith's Tool and Die for 40 years. Currently, he is only making one part, RL-5 which is a small electricial relay. He has a 2-year contract to provide 30,000 parts per month to Ford Motor. Unfortunately, Joe got quite sick and his son, Mike, has had to come in and run the business. Mike is disappointed when he finds the following monthly information about the RL-5 part: Per unit 30,000 units Sales Price: $22.00 660,000 Variable manufacturing costs $14.00 420,000 Variable selling costs $2.00 60,000 Fixed manufacturing overhead 150,000 Fixed administrative/selling costs 60,000 Operating income (30,000) Smith's Tool and Die has the capacity to produce 100,000 units of the RL-5 part per month. Mike comes to you to see what can be done about the current losses Smith's Tool and Die is experiencing.

You and Mike determine that there are three alternatives to consider: 1. Mike mentions that his friend's dad, Sam, also owns a tool and shop and also supplies the RL-5 part to other automotive businesses. Sam's business is doing very well and can't keep up with current production. Sam offers to purchase 50,000 units of RL-5 from Mike for $15.00 per unit. Since this is Mike's deal, no additional selling costs will be incurred.

2. Mike is also thinking about shutting down the business. Since he needs to the honor his contract with Ford, he has looked into outsourcing the part to Fred's Tool and Die. Fred offers to make the 30,000 parts per month for a price of $20 per unit. Outsourcing the part will reduce fixed manufacturing overhead by $80,000 and fixed administrative and selling costs by $30,000.

3. Mike can pay Ford a non-performance fee and sell the assets of the business. The fee is 10% of the sales revenue for one year. Mike has received an offer from Tony who will pay $1,200,000 for the assets. Tony plans to sell what assets he can, demolish the building and build condos on the land. The current net book value of the assets is $200,000. Assume that Smith's tax rate on the gain is 21%.

Required: 1. How much profit/loss will Mike realize if he accepts Sam's special order for 50,000 units? Show all computations: Incremental revenue: Incremental costs (list each cost individually)

2. List 3 qualitative issues that you think Mike should consider before accepting the special order: A. B. C.

3. How much profit/loss will Mike realize if he decides to outsource the part to Fred's Tool and Die? Show all computations Make Costs/revenues (list individually) inhouse Outsource Difference

4. List 3 qualitative issues that you think Mike should consider before outsourcing the part: A. B. C.

5. How much profit/loss will Mike realize if he sells the assets of the business to Tony? Show all computations

6. List 3 qualitative issues that you think Mike should consider before selling off the business: A. B. C.

7. Assess all of the three alternatives. Which do you recommend Mike choose? Why? Use at least 5 complete sentences.

Answer 1

Option - A : Calculation on Net profit/loss to Mike when he accepts Sam's special order for 50,000 units is as below,

Particulars	Units	Unit Rate	Value ($)
Incremental Revenue	50000	$    15.00	$    750,000.00
Incremental costs
- Variable manufacturing cost	50000	$ (14.00)	$ (700,000.00)
Incremental Income	(A)	$      50,000.00
Present operating loss	(B)	$    (30,000.00)
Net profit	(A) - (B)	$      20,000.00

Points to consider for opting option - A

1. Control measures to ensure there is incremental fixed cost due to special order

2. Consistency on the special order with agreed price and volume

3. Earning profit due to special order

Option - B : Profit / Loss due to Outsourcing - Fred's Tools & Dies
Particulars	Units	Unit Rate	Value ($)
Sales	30000	$    22.00	$    660,000.00
Cost of outsourcing	30000	$ (20.00)	$ (600,000.00)
Gross Profit			$      60,000.00
Revised Fixed manufacturing Overhead			$    (70,000.00)
Revised Fixed administrative and selling costs			$    (30,000.00)
Total Revised Fixed cost			$ (100,000.00)
Net loss due to outsourcing			$    (40,000.00)

Points to consider for opting option - B

1. Explore the possibilities of reducing the fixed cost

2. Other profitable business to be executed to observe the existing fixed cost

3. Not advisable to choose the option of outsourcing